Contracting-out: it would work in healthcare, too

In a new book entitled Pensions: Policies, New Reforms and Current Challenges, there is a chapter by two authors who readers of this blog may be familiar with, which makes the case for a restoration of the ‘contracting out’ principle. ‘Contracting out’ was a feature of the British welfare state which had grown out of Beveridge’s intention to provide a safety net without destroying private and voluntary initiative. Thus, people who did not wish to participate in the earnings-related state pension scheme were given the possibility to opt out of it, and receive national insurance rebates broadly equivalent to the pension entitlement foregone. They could then use those rebates to build up their own pension fund, individually or through their workplace.

It was not such a bad compromise between collectivist and voluntarist aims. This system is probably the main reason why the majority of British pensioners still have sizeable private pension funds, providing a major component of their old-age income. If successive governments had not eroded that system, the ticking of the pension time bomb would be a lot less menacing.

Re-establishing the contracting out system in the field of pensions would be relatively straightforward. It would not be a revolutionary step, but merely a return to a system which had worked satisfactorily for decades. But could the same principle be applied to other policy areas? Could we introduce opt-out clauses even for the NHS, without undermining the NHS itself (not that I’d have a problem with undermining it)?

The answer is yes – if a few preconditions are met. Firstly, rebates would have to be age-specific, corresponding to the average healthcare costs of each cohort. They would be huge for, say, a 70-year old, but quite modest for a 25-year old. People could then use those rebates to ensure themselves against health risks in the way they see fit. They could contract a private for-profit insurer, a cooperative/mutual insurer, a friendly society (yes, a few of them still exist), or whatever alternative there is or might emerge.

By now, I can hear you screaming at the screen: ‘But all the healthy people would bunk off, leaving the NHS with the sickest and hardest to treat!’ So let’s move on to the second pre-condition, which is the installation of a risk structure compensation formula. This is what social insurance systems in Continental Europe have done when they introduced free choice of health insurers. In these systems, broadly speaking, insurers with a healthier client base compensate those with a less healthy one. Cost differences between insurers that are due to difference in their clients’ health status are thereby levelled, and an insurer has no reason to prefer a healthy customer over one with multiple chronic illnesses.

If contracting-out, combined with risk-equivalisation, was introduced in the UK, it would create competition between insurers. This, in turn, would spur competition between providers. The Labour reforms that the party is now so embarrassed about were all about creating a measure of provider competition; and to the party’s even greater embarrassment, it worked, as far as it went. It just never got very far, because Labour’s aim of encouraging independent sector providers to enter the system never took off. Competition was thus limited to providers that were still part of the same old NHS. Birds of a feather will not pick at each other’s eyes, or however the proverb goes.

Successive governments have talked about ‘putting patients first’, but guess what, in a provider-centric system, the patient will never come first. True patient power is not the power to fill out a complaints form that nobody reads, or the power to write a letter to an MP, to receive a standardised response sent out by the MP’s intern. No, if we want to see true patient power, we have to give them the right to exit the NHS altogether, and take their money elsewhere.

Head of Political Economy

Dr Kristian Niemietz is the IEA's Head of Political Economy. Kristian studied Economics at the Humboldt Universität zu Berlin and the Universidad de Salamanca, graduating in 2007 as Diplom-Volkswirt (≈MSc in Economics). During his studies, he interned at the Central Bank of Bolivia (2004), the National Statistics Office of Paraguay (2005), and at the IEA (2006). He also studied Political Economy at King's College London, graduating in 2013 with a PhD. Kristian previously worked as a Research Fellow at the Berlin-based Institute for Free Enterprise (IUF), and taught Economics at King's College London. He is the author of the books "Socialism: The Failed Idea That Never Dies" (2019), "Universal Healthcare Without The NHS" (2016), "Redefining The Poverty Debate" (2012) and "A New Understanding of Poverty" (2011).

1 thought on “Contracting-out: it would work in healthcare, too”

  1. Posted 19/02/2014 at 17:37 | Permalink

    I’m afraid Kristian’s last sentence hits the nail on the head. One of the conclusions in my study of six government project disasters (relating especially to three of them) was that politicians and civil servants simply don’t understand the workings of markets where customers have a genuine choice. That’s why I don’t call the NHS a state ‘monopoly’ but a state ‘monoparechy’ — that is, not a ‘single seller’ but a ‘single provider’. The name hasn’t caught on yet — but give it another fifty years and who knows?

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